Returning Greece to the Drachma

The standard of living reached in Greece since it joined the European Union means austerity will be inadequate to rebalance the economy. Returning Greece’s currency to the drachma, on the other hand, would allow market forces to set the country’s wage levels, induce other indebted European Union members to reform without Continental prodding and thus solidify the euro.

Greece’s gross domestic product per capita of $30,400 in 2008 was close to the European Union average. It was caused not by an exceptional surge in productivity, but mostly by huge subsidies and extensive borrowing. Greece’s continuing current account deficit, estimated by The Economist at 8.3 percent of gross domestic product in 2011 despite a severe recession, indicates that it remains deeply uncompetitive.

By comparison, 2008 G.D.P. per capita in Bulgaria was reported as $14,000 and in Macedonia, $10,700. Yet it has been 20 years since Communism fell and market forces are dominant in both economies. Even Portugal’s G.D.P. per capita falls short of Greece’s.

This suggests Greece may require living standards to decline by as much as 40 percent to become competitive. Such an adjustment is impossible through austerity alone. Civic unrest shows further belt-tightening could produce political reactions deeply damaging to Greece’s future. Assuming further subsidies from European Union taxpayers are politically unlikely, a Greek replacement of the euro by a new drachma seems to be the only alternative.

This would be problematic, but not impossible. The two most relevant precedents are Argentina, which in 2001-2 abandoned a one-to-one link between the peso and dollar, and the new states created from the former Soviet Union and Yugoslavia, which introduced new currencies.

In Argentina, the government first imposed a limitation of around $250 a week on cash withdrawals from banks. Peso convertibility was abandoned in January 2002 and an official exchange rate of 1.4 pesos per dollar was created, at which all dollar bank accounts were required to convert. Since the free-market rate settled around 4 pesos per dollar, most capital losses were borne by savers, not banks.

Photo

Under the drachma, tourism to ancient sites could help ease the lack of jobs.Credit
Louisa Gouliamaki/Agence France-Presse — Getty Images

Logistically, security printing of drachma banknotes would not initially be necessary. When Slovenia introduced the tolar in October 1991 as Yugoslavia was breaking up, it operated for more than a year with a paper currency without security printing. In Greece, cash transactions could alternatively be made in euros, available from the banks at a free-market rate once bank accounts were converted into drachmas.

The exchange would require some unpleasant temporary restrictions. As well as restricting cash withdrawals from banks, short-term exchange controls would be needed and the Schengen rights of free movement between Greece and other European Union countries might need to be suspended temporarily. With these restrictions, conversion could require a bank holiday no longer than the eight-day period the United States imposed in 1933.

Economically, the drachma’s value would fall sharply. The price of a Mercedes would jump in Athens, but those of haircuts and moussaka would not immediately rise. The equilibrium drachma rate would make Greek workers internationally competitive, producing a decline in living standards between the 18 percent needed to match Portugal’s and the 50 percent to reach Bulgarian levels.

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Greece also could quickly achieve a trade surplus. Inexpensive tourist offerings would help push unemployment down rapidly from its current rate of more than 16 percent. A debt restructuring similar to Argentina’s could then be undertaken, reducing the debt’s present value by around the same percentage as the Greek reduction in living standards.

This process would be painful, although the increased economic vibrancy and decline in joblessness for many Greeks might make it preferable to several years of externally imposed austerity and political chaos. For the European Union and the euro, it would be highly beneficial, eliminating most of the moral hazard inherent in the euro zone’s current fiscal and monetary arrangements.

The decline in Greek living standards imposed by such a switch back to the drachma might well encourage the euro zone’s other weak economies to impose the austerity measures and reforms needed to make themselves competitive. The euro also would probably emerge stronger because Maastricht-type fiscal and economic discipline would appear to be the necessity of a cruel market, and not something bargained at a European summit meeting and chiseled by fudging figures.

Finally, such an outcome would make central control by the European Union of the Greek state’s finances unnecessary. Good behavior would result from self-discipline alone. MARTIN HUTCHINSON

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A version of this article appears in print on September 12, 2011, on Page B2 of the New York edition with the headline: Returning Greece to the Drachma. Order Reprints|Today's Paper|Subscribe